Reducing Inheritance Tax

The government’s Inheritance Tax take surged by 8% to more than £5.2 billion for the first time in the year to April 2018, according to HMRC – and bills are expected to rise further. However, you could reduce the impact on your estate after two years using Business Property Relief. Our financial planning expert, Anthony Ward, explains.

Inheritance Tax is rising for a number of reasons. For several years now, the Inheritance Tax threshold – below which no tax is payable – has been capped at £325,000 and it will remain at this level until April 2021. At the same time, property and other asset prices have risen strongly, increasing the value of estates.

Ways to reduce or mitigate Inheritance Tax include gifts and trusts, but these can take seven years to be fully effective. They can also involve compromises, such as giving up control and access to your assets.

This is where Business Property Relief can help. Where it applies, you can reduce your Inheritance Tax liability in two years and still retain control of your assets.

What is Business Property Relief?

Business Property Relief (BPR) is tax relief designed to increase investment in certain types of trading businesses. It was introduced by the UK government in 1976.

Where it applies, you are exempt from paying Inheritance Tax on your share of a business partnership, or on the value of unquoted shares.

Other investments, including land, buildings, plant and machinery used by relevant businesses, qualify for 50% Inheritance Tax relief. Business property must be held for at least two years before death.

What are Business Property Relief Investments?

A number of specialist firms offer BPR investments. They usually buy baskets of unquoted shares on behalf of investors and use a wide range of investment strategies to suit individual preferences. There are risks, however. No matter how well they’ve done in the past, shares can still fall in value, and shares in smaller, unquoted companies can be riskier and less liquid than quoted shares. Shares are also subject to product charges.

How Inheritance Tax works

No Inheritance Tax is paid on estates valued up to £325,000 – the ‘nil-rate’ threshold – and 40% is paid on amounts above this. This threshold is frozen until 5 April 2021, after which it is set to increase with inflation. The threshold applies to each individual in a marriage or civil partnership.

When an estate is above the nil-rate threshold and includes a family home being passed to direct descendants, it may also be entitled to an additional ‘residence’ nil-rate threshold (there’s no Inheritance Tax to pay when leaving a home to a spouse or civil partner).

For the 2018/19 tax year, this additional threshold raises the nil-rate threshold to £450,000. This also increases by £25,000 in each subsequent tax year until 5 April 2021, after which it’ll increase in line with inflation. However, estates worth more than £2 million lose this additional threshold at a rate of £1 for every £2 over the £2 million threshold.

Gifts between spouses or civil partners, whether made in life or on death, benefit from a spouse exemption, and can be passed on tax-free. Unused nil-rate and residence nil-rate threshold can be passed on in this way, too, which means a surviving partner’s threshold could be as much as £900,000 in 2018/19.

BPR case study

Mr Mitchell, aged 75, has an estate worth £4 million, including a £1 million house, investments of £2.2 million and £800,000 in cash. He has no mortgage on his house and intends to live there until he dies. His wife died a few years ago and, at this time, used all of her nil-rate threshold to leave assets to their children. He would like his two children and four grandchildren to inherit his estate.

If Mr Mitchell does nothing to maximise the value of his estate, his beneficiaries will need to pay Inheritance Tax on £4 million, less his £325,000 nil-rate threshold (the value of the estate means the residence nil-rate threshold doesn’t apply). That means 40% Inheritance Tax would be due on £3.675 million, giving a tax bill of £1.47 million.

So Mr Mitchell decides to invest £600,000 of his excess cash into BPR. After holding these BPR shares for two years, the then-current value of his investment becomes exempt from Inheritance Tax. Assuming the value of these shares doesn’t change in the meantime, just to keep things simple, the taxable value of his estate is reduced accordingly, to £3.075 million. As long as Mr Mitchell still holds the shares when he dies, the Inheritance Tax bill would now be £1.23 million – a reduction of £240,000.

Learn more about Estate Planning by getting in touch with your Wealth Manager who can introduce you to one of our Wealth Planners.

Nothing contained in this article should be construed as constituting legal, financial or tax advice. Tax rules and legislation can change, and the benefits and drawbacks of a particular tax treatment will vary with individual circumstances.

We recommend that you take professional advice where required. You have sole responsibility for the management of your tax, financial and legal affairs, including making any applicable filings and payments, and complying with any applicable laws and regulations.